Climate Risk and Financial Stability: A Systemic Risk Perspective from Thailand

Understanding the impact of climate risks on financial stability is crucial for ensuring the resilience of banking sectors, particularly in economies exposed to climate change. This paper investigates how transition and physical risks influence systemic risk in Thailand’s banking sector. Transition risks are analyzed using the Fama-French multi-factor asset pricing model to estimate the risk premium of brown industries relative to green industries, termed Brown-minus-Green (BMG). Physical risks are assessed using the Standardized Precipitation Evapotranspiration Index (SPEI), an indicator of flood and drought conditions. Systemic risk at the bank level is measured using conditional value-at-risk (CoVaR). Panel regressions are employed to examine the relationship between climate risks and systemic risk. The results reveal that transition risks, as captured by the BMG factor, significantly heighten systemic risk among Thai banks, emphasizing their critical role in financial vulnerabilities. Additionally, physical risks, particularly those associated with flood exposure, create substantial challenges for bank portfolios. These findings highlight the importance of integrating transition and physical risk indicators into regulatory monitoring frameworks to enhance financial stability. Furthermore, Thai commercial banks can apply these insights to conduct climate stress tests and develop strategies for managing climate-related risks more effectively.